Lloyd v. Commissioner ( 2000 )

T.C. Memo. 2000-299
UNITED STATES TAX COURT
ROBERT LLOYD, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 1477-97, 6774-97. Filed September 25, 2000.
Irvin W. Fegley, for petitioner.
Margaret S. Rigg, for respondent.
MEMORANDUM OPINION
DAWSON, Judge: These cases were assigned to Special Trial
Judge Norman H. Wolfe pursuant to the provisions of Rules 180,
181, and 183. All section references are to the Internal Revenue
Code in effect at the time the petition was filed, unless
otherwise indicated. All Rule references are to the Tax Court
Rules of Practice and Procedure. The Court agrees with and
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adopts the opinion of the Special Trial Judge, which is set forth
below.
OPINION OF THE SPECIAL TRIAL JUDGE
WOLFE, Special Trial Judge: These cases are before the
Court on petitioner’s motion for an award of reasonable
litigation costs under section 7430 and Rules 230 through 233.
Respondent determined deficiencies in, and additions to,
petitioner’s Federal income taxes as follows:
Additions to Tax
Year Deficiency Sec. 6651(a)(1) Sec. 6662(a)
1992 $46,172 $11,543 $9,234
1993 28,796 7,199 5,759
1994 73,332 –- 14,666
After these cases were docketed, the parties filed a
stipulation of settled issues that disposed of all adjustments
without trial. Thereafter, petitioner filed motions for
litigation costs and respondent filed objections to petitioner’s
motions. Neither party has requested a hearing, and the Court
concludes that a hearing is unnecessary for the proper
disposition of these motions. See Rule 232(a)(2).
These related cases have been consolidated for the purpose
of considering petitioner’s motions. At the time the petitions
were filed, the petitioner resided in Beijing, People’s Republic
of China.
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A. The 1992 Tax Year Audit
On August, 29, 1994, petitioner filed his 1992 Federal
income tax return using the following mailing address: 67
Rosewood Drive, Atherton, California 94027 (the Atherton
address). On June 14, 1995, respondent mailed petitioner a
letter informing him that his 1992 Federal income tax return had
been selected for audit. Respondent’s audit letter requested
that petitioner contact respondent within 10 days to arrange an
interview and bring to the interview complete records concerning
specified claimed deductions. On July 31, 1995, petitioner
called respondent and arranged an initial interview. Petitioner
failed to attend the interview. On August 29, 1995, respondent
mailed a notice of proposed deficiency (30-day letter) to
petitioner at the Atherton address.
On September 25, 1995, petitioner faxed to respondent a
handwritten letter informing respondent that he had moved to
Beijing, China, and that he needed additional time to furnish the
requested information. Petitioner further stated that he was
unable to find his business records and that he needed more time
to recreate them using his check register and credit card
statements.
Petitioner asserts that he responded to respondent’s audit
letter by delivering a letter and three boxes of documents to
respondent on November 30, 1995. Petitioner contends that the
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position respondent took in his answer was not substantially
justified because respondent failed to review the documents prior
to issuing the notice of deficiency. Respondent asserts that
petitioner did not deliver a letter or records on November 30,
1995. Respondent’s records do not contain an entry that
indicates that petitioner delivered a letter or documents on
November 30, 1995.
On August 7, 1996, respondent issued a notice of deficiency
to petitioner using the Atherton address. On January 15, 1997,
respondent mailed an additional copy of the notice of deficiency
to petitioner in Beijing, China. In the notice of deficiency,
respondent took the position that petitioner failed to report
income of $175,984 on his 1992 Federal income tax return and
failed to substantiate certain claimed deductions. Petitioner
filed a petition with this Court on April 9, 1997.
B. The Audit of the 1993 and 1994 Tax Years
Petitioner filed his 1993 Federal income tax return on
January 12, 1995, using the Atherton address. On October 13,
1995, petitioner filed his 1994 Federal income tax return using
the following mailing address: 50 Victoria Avenue, Millbrae,
California 94030 (the Millbrae address).
On April 4, 1996, respondent mailed a letter to petitioner
informing him that an audit of petitioner’s 1994 Federal income
tax return had been opened. This letter was sent to the Millbrae
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address. The letter requested that petitioner contact respondent
to arrange a conference and also requested substantiation of
petitioner’s claimed deductions.1
Petitioner asserts that on May 28, 1996, he faxed to
respondent a letter informing respondent that he had moved to
Beijing, China. Respondent claims that he did not receive this
letter.
On May 29, 1996 respondent mailed a 30-day letter to both
the Atherton and Millbrae addresses. This letter proposed
adjustments to petitioner’s 1993 and 1994 tax returns and
indicated that petitioner could request an Appeals Office
conference.
On July 15, 1996, respondent’s auditors sent petitioner’s
1993 and 1994 administrative files to the Examination Support
Procedure (ESP) unit for the preparation of a notice of
1
Respondent alleges that on Mar. 26, 1996, respondent sent a
letter to petitioner at both the Atherton and Millbrae addresses
indicating that respondent had opened an audit for the 1993 tax
year. According to respondent, the audit letter requested that
petitioner contact respondent to arrange a conference and to
provide information concerning petitioner’s claimed deductions.
Respondent also states that the audit letter that was sent to the
Atherton address was returned as undeliverable and that the U.S.
Postal Service attached to the letter a mailing label that
indicated that petitioner’s new address was the Millbrae address.
Respondent also claims that the U.S. Postal Service did not
return the letter that was sent to the Millbrae address. These
allegations are supported by the affidavit of Barbara Gee,
manager of the Office Audit Section of the San Mateo Office of
the IRS. Copies of the documents Ms. Gee refers to are not
included in the record.
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deficiency. On July 23, 1996, petitioner delivered three boxes
of documents regarding his 1993 and 1994 tax years to
respondent’s auditors. At this time, petitioner was informed by
Barbara Gee (Gee), respondent’s auditor, that her office no
longer had petitioner’s administrative files and that she could
not review petitioner’s documents without the administrative
files. Consequently, Gee requested that petitioner contact ESP
to request that his administrative files be sent back to Gee’s
office. Gee also requested that petitioner make an appointment
to review his documents with respondent’s auditors. Petitioner
was unwilling to make an appointment.
On August 16, 1996, respondent sent a notice of deficiency
for the 1993 and 1994 tax years to the Millbrae address. On
August 27, 1996, another copy of the notice was sent to
petitioner in Beijing, China. In the notice of deficiency,
respondent determined deficiencies, partly because petitioner
failed to substantiate deductions he claimed on his 1993 and 1994
Federal income tax returns.
On October 11, 1996, petitioner requested that ESP send the
1993 and 1994 administrative files back to respondent’s auditors.
The administrative files were sent back to respondent’s auditors
on October 18, 1996.
On November 12, 1996, Peter Phillips (Phillips),
respondent’s auditor, spent 1 day reviewing petitioner’s
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documents. Phillips attempted to organize and analyze the
documents submitted by petitioner. However, without petitioner’s
explanation and assistance Phillips found it difficult to review
and understand the documents. After spending a day reviewing the
case, Phillips discussed his difficulties with Gee. Gee decided
that Phillips should not spend any more time reviewing the
documents. As a result of Phillips’ review, respondent issued a
supplemental report for 1993 that allowed a substantial portion
of petitioner’s claimed Schedule C, Profit or Loss From Business,
expenses. The supplemental report did not make any adjustments
to petitioner’s 1994 tax year. Petitioner in writing disagreed
with the supplemental report, offered to meet with respondent’s
representative, and then filed a petition with this Court on
January 24, 1997.
C. Post-Petition
Respondent filed an answer to the petition in the case
concerning the 1993 and 1994 years on March 7, 1997, and filed an
answer to the petition in the case concerning the 1992 year on
May 16, 1997. In both answers, respondent maintained the
positions taken in the notices of deficiency.
On June 25, 1997, and June 27, 1997, Ms. Geraldine Melick
(Melick), an Appeals officer, met with petitioner regarding both
cases. At the meeting petitioner explained many matters that
were not evident from his records. First, he described the
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prenuptial agreement between himself and his wife that affected
the division of business income and expenses. Second, he
disclosed the source of unreported income with respect to his
1992 tax year. Third, he explained how his business had large
profits in some years and large losses in others.
On June 27, 1997, Melick offered to concede all adjustments
for the 1992 tax year. Melick also requested additional
information regarding the 1994 tax year, and she indicated that
respondent would concede the adjustments for the 1993 and 1994
tax years upon the receipt of such information. On July 2, 1997,
petitioner provided the additional information sought by
respondent. Upon receipt of the information, respondent conceded
the adjustments for the 1993 and 1994 tax years.
Discussion
A taxpayer who has substantially prevailed in a Tax Court
proceeding may be awarded reasonable litigation costs incurred in
such proceedings. See sec. 7430(a)(2). Under section 7430, a
judgment for litigation costs incurred in connection with a court
proceeding may be awarded only if a taxpayer: (1) Has exhausted
his administrative remedies within the IRS; (2) has substantially
prevailed with respect to the amount in controversy or the most
significant issue or set of issues presented; (3) has satisfied
the applicable net worth requirement; and (4) did not
unreasonably protract the court proceeding.
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However, the taxpayer fails to qualify as the prevailing
party if the Commissioner establishes that his position was
substantially justified. See sec. 7430(c)(4)(B)(i). Respondent
bears the burden of proving that respondent’s position was
substantially justified. See id.
After concessions by respondent,2 the issues for decision
are: (1) Whether respondent’s positions were substantially
justified; (2) whether petitioner exhausted his administrative
remedies for the 1993 and 1994 tax years; and (3) whether the
amount of costs and attorney’s fees claimed by petitioner are
reasonable.
A. 1992 Tax Year
Because of the concessions made by respondent, the sole
issue for determination for the tax year 1992 is whether
respondent’s position was substantially justified.
For purposes of an award of litigation costs, the position
of the United States is the position taken by the United States
in a judicial proceeding. See sec. 7430(c)(7)(A). The United
States took a position in these judicial proceedings when it
filed an answer to the petition. See Huffman v. Commissioner,
978 F.2d 1139, 1148 (9th Cir. 1992), affg. in part, revg. in part
2
Respondent concedes that petitioner has: (1) Substantially
prevailed in the proceedings; (2) satisfied the net worth
requirements; and (3) not unreasonably protracted the Court
proceedings. Respondent also concedes that petitioner exhausted
his administrative remedies with regard to 1992.
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and remanding T.C. Memo. 1991-144; Maggie Management Co. v.
Commissioner, 108 T.C. 430, 442 (1997).
Whether respondent’s position was substantially justified
turns on a finding of reasonableness, based upon all the facts
and circumstances, as well as the legal precedents relating to
these cases. See Pierce v. Underwood, 487 U.S. 552 (1988); Sher
v. Commissioner, 89 T.C. 79, 84 (1987). A position is
substantially justified if the position is justified to a degree
that could satisfy a reasonable person. See Pierce v. Underwood,
supra at 565; Maggie Management Co. v. Commissioner, supra at
443. A position must have a reasonable basis both in law and
fact. See Pierce v. Underwood, supra at 563-565. The fact that
respondent eventually loses or concedes a case does not by itself
establish that respondent’s position was unreasonable. See
Maggie Management Co. v. Commissioner, supra at 443; Sokol v.
Commissioner, 92 T.C. 760, 767 (1989).
Petitioner asserts that he delivered documents regarding the
1992 tax year to respondent on November 30, 1995. Petitioner
further asserts that the position respondent took in his answer
was not substantially justified because respondent failed to
review the documents prior to filing an answer. Respondent
contends that he did not receive the documents prior to filing
his answer.
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At the time the answer was filed, respondent’s position was
substantially justified because petitioner failed to substantiate
claimed deductions and to disclose the source of unreported
income. Deductions are a matter of legislative grace, and
taxpayers must substantiate their entitlement to a deduction.
See New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934).
Moreover, section 6001 imposes on taxpayers a duty to maintain
books and records sufficient to support items reported on their
returns.
On this record, we are not convinced that respondent
received the documents in question with respect to the 1992
return on November 30, 1995. Respondent’s records do not contain
an entry that indicates that respondent received the documents.
Moreover, respondent generally provides a receipt to taxpayers
upon delivery of documents, and in the exercise of prudence a
business person delivering important documents would obtain a
receipt or other proof of delivery. In this case, the record
does not contain any such receipt or credible proof of delivery.
Even if we were to assume that petitioner delivered the
documents on November 30, 1995, we find that the documents fail
to substantiate petitioner’s tax return positions. In his
answer, respondent took the position that petitioner failed to
report income of $175,984. The letter that petitioner supposedly
sent to respondent on November 30, 1995, does not provide an
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explanation concerning unreported income. Furthermore,
petitioner’s letter indicates that petitioner attempted to
substantiate some of his claimed business expenses with his
wife’s receipts. Petitioner’s letter did not describe the
prenuptial agreement between himself and his wife, which affected
the division of business income and expenses. Petitioner did not
disclose the terms of the prenuptial agreement until the Appeals
conference in June 1997.
Accordingly, respondent was reasonable in refusing to
concede the adjustments until petitioner substantiated his
deductions and disclosed the source of his unreported income.
See Sokol v. Commissioner, supra at 765. Therefore, we hold that
respondent’s position was substantially justified at the time the
answer was filed.
B. 1993 and 1994 Tax Years
Petitioner is not entitled to litigation costs for the tax
years 1993 and 1994 because he failed to exhaust his
administrative remedies. “A judgment for reasonable litigation
costs shall not be awarded * * * in any court proceeding unless
the court determines that the prevailing party has exhausted the
administrative remedies available to such party within the
Internal Revenue Service.” Sec. 7430(b)(1). In general, a
taxpayer has not exhausted the administrative remedies available
within the IRS unless prior to filing a petition in the Tax
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Court, he participates in an Appeals Office conference or at
least requests such a conference and files a written protest if
one is required in order to obtain an Appeals Office conference.
See sec. 301.7430-1(b)(1), Proced. & Admin. Regs.
On May 29, 1996, respondent sent a 30-day letter regarding
petitioner’s 1993 and 1994 tax years to both the Atherton and
Millbrae addresses. The 30-day letter indicated that petitioner
could request an Appeals Office conference. Petitioner failed to
respond to this letter.
Petitioner attempts to excuse this failure by relying upon
section 301.7430-1(e), Proced. & Admin. Regs. Under this
regulation, a party is deemed to have exhausted his
administrative remedies if the party did not receive the notice
of proposed deficiency (30-day letter) prior to the issuance of
the statutory notice and the failure to receive such notice was
not due to actions of the party (such as a failure to supply
requested information or a current mailing address to the
District Director or service center having jurisdiction over the
tax matter) and the party does not refuse to participate in an
Appeals conference while the case is in docketed status. See
sec. 301.7430-1(e)(2), Proced. & Admin. Regs.
Petitioner’s reliance on the regulation is misplaced because
petitioner’s own actions contributed to his failure to receive
the 30-day letter. On September 25, 1995, petitioner mailed
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respondent a letter indicating that he had moved to Beijing,
China. However, on October 13, 1995, petitioner filed his 1994
Federal income tax return using the Millbrae address.
Accordingly, we find that respondent sent the 30-day letter to
petitioner’s last known address in Millbrae, California.
Respondent was entitled to rely upon petitioner’s 1994 tax return
in order to determine petitioner’s last known address. Cf.
Abeles v. Commissioner, 91 T.C. 1019 (1988) (Commissioner is
entitled to treat the address on the taxpayer’s most recent
return as the taxpayer’s last known address absent a clear and
concise notification of an address change).3
Consequently, we find that petitioner failed to request an
Appeals Office conference prior to filing a petition in the Tax
Court. Therefore, petitioner failed to exhaust his
administrative remedies, and he is not entitled to litigation
costs with regard to the 1993 and 1994 tax years.
Moreover, the position that respondent took in his answer
was substantially justified. When respondent filed his answer,
he did not have sufficient information to conclude that
3
Even if petitioner faxed, as he alleges, a letter to
respondent on May 28, 1996, indicating that his mailing address
was in Beijing, China, this letter did not constitute a timely
change of address for purpose of the 30-day letter mailed on the
following day. Cf. Rose v. Commissioner, T.C. Memo. 1992-739
(tax return filed 45 days prior to the mailing of a notice of
deficiency did not constitute timely notice of change of
address).
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petitioner’s claimed deductions were substantiated. Respondent’s
auditors reviewed petitioner’s records before respondent filed
his answer. At the time of the review, petitioner was not
available to provide assistance or information concerning his
records. Without the benefit of petitioner’s assistance,
respondent’s auditors found that the records failed to
substantiate petitioner’s tax return positions. We are not
persuaded by petitioner’s apparent argument that he is entitled
to leave with respondent a box containing some of his records
without adequate explanation and expect that respondent’s
auditors somehow will figure out the details of his business and
finances without the benefit of assistance or explanation by
petitioner.
After respondent filed his answer, an Appeals conference was
held promptly. At the Appeals conference, petitioner disclosed
the terms of his prenuptial agreement, which affected the
division of business income and expenses. As soon as this
information was disclosed, together with other explanations and
documents requested by the Appeals officer, respondent allowed
petitioner’s claimed deductions and conceded that petitioner was
not liable for the additions to tax.
For purposes of determining the reasonableness of
respondent’s position, the Court considers the facts known to
respondent at the time the position was taken. When respondent
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filed his answer, he did not have the benefit of the
substantiating information and explanations that petitioner
provided at the Appeals conference. Accordingly, we hold that
respondent was substantially justified at the time the answer was
filed.
Conclusion
For the foregoing reasons, petitioner is not entitled to a
recovery of litigation costs. Based on this conclusion, we need
not and do not decide the reasonableness of the claimed expenses.
Appropriate orders and
decisions will be entered.